A corporation may declare dividends only out of its unrestricted retained earnings (surplus profits); it cannot pay dividends out of capital, because capital must be preserved to protect creditors. Cash dividends are declared by the board of directors alone. Stock dividends — distributions of the corporation's own shares — require both board approval and the approval of stockholders representing at least two-thirds of the outstanding capital stock, because they affect the capital structure. There is also an important limit against hoarding: stock corporations are generally prohibited from retaining surplus profits in excess of one hundred percent (100%) of their paid-in capital, except when justified by a definite corporate expansion project, when prohibited by a loan agreement from declaring dividends without the lender's consent, or when retention is necessary under special circumstances. Excess retained earnings held without justification may be subject to an improperly accumulated earnings tax. Stockholders generally have no vested right to dividends until they are declared by the board.
When does a stockholder get a share of the profits? Only when the corporation declares dividends — and the law strictly controls where dividends can come from.
Dividends Come Only From Retained Earnings
A corporation may declare dividends only out of its unrestricted retained earnings (surplus profits). It cannot pay dividends out of capital, because the capital must be preserved to protect creditors. Paying dividends from capital would be an unlawful return of capital.
Cash Dividends vs. Stock Dividends
- Cash dividends — declared by the board of directors alone; and
- Stock dividends (distributions of the corporation's own shares) — require board approval plus the vote of stockholders representing at least two-thirds (2/3) of the outstanding capital stock, because they affect the capital structure.
The Limit Against Hoarding Profits
Corporations cannot simply hoard profits indefinitely. Stock corporations are generally prohibited from retaining surplus profits in excess of 100% of their paid-in capital — except when the retention is justified by:
- A definite corporate expansion project or program approved by the board;
- A loan agreement that prohibits dividends without the lender's consent; or
- Special circumstances making retention necessary (such as reserves for probable contingencies).
Improperly Accumulated Earnings
Excess retained earnings held without justification may expose the corporation to an improperly accumulated earnings tax, which discourages using the corporate form to shield profits from being distributed and taxed at the stockholder level.
No Vested Right Until Declared
A stockholder generally has no vested right to dividends until they are declared by the board. Even if the corporation is profitable, the board's business judgment on whether to declare (subject to the retention limit) generally governs — a stockholder cannot ordinarily compel a dividend.
Practical Takeaways
- Dividends may be declared only from unrestricted retained earnings — never from capital;
- Cash dividends need only the board; stock dividends need the board and a two-thirds stockholder vote;
- Corporations generally cannot retain surplus over 100% of paid-in capital without justification, and stockholders have no vested right to dividends until declared.
Frequently Asked Questions
Where can a corporation get money to pay dividends? Only from its unrestricted retained earnings (surplus profits). A corporation cannot pay dividends out of capital, because capital must be preserved to protect creditors.
What is the difference between cash and stock dividends? Cash dividends are declared by the board of directors alone. Stock dividends, which distribute the corporation's own shares, require board approval plus the vote of stockholders representing at least two-thirds of the outstanding capital stock.
Can a corporation keep all its profits and never declare dividends? Generally no. Stock corporations are prohibited from retaining surplus profits in excess of 100% of their paid-in capital, except when justified by a definite expansion project, a loan agreement prohibiting dividends, or special circumstances requiring retention.
Do stockholders have a right to demand dividends? Generally no. A stockholder has no vested right to dividends until the board declares them. Subject to the retention limit, the board's business judgment on whether to declare generally governs.
This commentary is for general informational purposes only and does not constitute legal advice. For guidance specific to your situation, please consult a licensed attorney.
If you have questions about your rights or options under Philippine law, our firm is available to assist. You may reach us via Viber or WhatsApp, call us at 0995 433 5550, or send an email to vivasnobles@gmail.com. We look forward to hearing from you.